Asset Price Dynamics and Infrequent Trades

Abstract

We model an economy where stocks and bonds (consols) are traded by two types of agents: speculators, expected utility maximizers always present in the market, and infrequent traders, whose trading motives are not explicitly modeled. A solution technique for equilibrium prices is developed when trades are triggered by stock prices reaching some threshold level, corresponding to a specific value of the dividend flow. Across trade scenarios we find expectations of stock sales to depress stock prices relative to the no-trade case, while expectations of stock purchases tend to inflate them .both effects bring about heteroskedasticity and predictability of stock returns. Our analysis yields insights as to the equilibrium effects of a variety of trading strategies, which mechanically generate market orders in response to changes in stock prices.